Draft Copy

A Study on Wealth Creation

(Rs. in Cr) Inquire Rank FASTEST CAGR % of adjusted mcap (91 to 96) 98.0 95.3 89.7 89.0 85.7 79.9 79.8 76.9 75.6 75.6 Rank based on size BIGGEST Amount of Wealth Created 1991-96 9102.2 7829.4 7074.0 5736.2 4923.0 4005.3 3144.4 3112.4 2755.2 2394.5

1 2 3 4 5 6 7 8 9 10

Dr Reddys Labs Vysya Bank TVS Suzuki United Phosphorus Oriental Hotels Himatsingka Seide Indian Hotels H D F C Trafalgar House Essel Packaging

1 2 3 4 5 6 7 8 9 10

Hind Lever SBI Telco ITC Bajaj Auto Hindalco Indian Hotels Tata Chemicals Ranbaxy Labs Castrol

Conclusions
Wealth Creating companies have a substantially high ROE and ROCE. A high correlation is seen between ROE and PE for the Wealth Creators group - Inquire 100. Mid cap stocks have a propensity to create wealth faster as compared to the heavyweight blue chips. Companies focused on their core businesses form 87% of the group. Dilution of capital per se does not detract from Wealth Creations.

Raamdeo Agrawal (9122) 207 3809

Volume III No.6 June 18, 1996

MOTILAL OSWAL Queen's Mansion, 2nd Floor, A.K.Naik Marg, Behind Khadi Gramodyog, Fort, Bombay 400 001. TEL: (9122) 207 1379 FAX : (9122) 207 6686

Contents
Concept Methodology Wealth Creators Management Industry analysis Categorisation Capitalisation size Sales growth (CAGR) Capital intensity Debt growth (CAGR) P/E - Tax ratio correlation Equity dilution Dividend payout Return on equity (ROE) ROE relative ROCE & ROE An observation on valuation Conclusion Inquire 100 Inquire 100
(Sorted alphabetically)

3 3

4 5 6 6 7 7 8 8 9 9 10 10 11 12 12 Appendix I Appendix II

Concept
The ability of a company to enhance the market value of the capital entrusted to it by its shareholders is the creation of shareholder wealth. This is the basic measure of success for a commercial venture. A Wealth Creator is a Company which enhances its market value by rational actions in a sustained manner. The study is targeted towards determining which enterprises are most likely to achieve this, and the purpose of this study is an attempt to capture the characteristics of Wealth Creators. For an investor, the wealth created by the company is the difference between his investment cost (adjusted for dilutions) and the market value of his holdings. An equity investor needs to be adequately compensated for the risk he bears and thus the wealth generated, through equity investment must be greater than that from other relatively low risk assets. At the time of an investment decision we are familiar with the financial statistics of the company, its management, products, etc. yet do we stop to ask ourselves, "Does this Company have the ability to create great wealth for us on a sustained basis?". We hope this study brings us closer to the answer.

Methodology
For the purpose of our study we have identified the 100 top Wealth Creators over the last five years (1991-96) in the Indian Stock Market. These companies have the distinction of having atleast quadrupled their market capitalisation over this period (adjusted for dilutions) which gives a CARG of 32% p.a. or higher. A bench mark of Rs.100 crores in Wealth Creation has been a qualification criterion for this group which we have termed the "Inquire 100". The ranks have been accorded on the basis of the speed of wealth creations i.e. compounded growth in wealth over the period of study. The database used for this study is that of Capitaline Ole and Trends.

Wealth Creators - Management

Tatas Birla TVS Ajay Piramal Anji Reddy Jindal L M Thapar Rane Sterlite FERA Others

10 3 3 2 2 2 2 2 2 32 40

The bulk of the Inquire 100 belong to well established groups known for their managerial acumen.

MNC's form a disproportionately large percentage of the Inquire 100, given that they account for less than 5% of the total population of listed companies. The group of First Generation entrepreneurs is strikingly large at 23%. The presence of the Joint Sector is very low.

Wealth Creators - Industry Analysis

Pharmaceuticals Automobile Automobile Accessories Cement Hotels Electrical Equipment Pesticides Packaging Speciality Chemicals Aluminium Banks Cable Cigarettes Compressors / Drilling Equipments Machine Tools Paint Personal Products Power Generation Tyres Others*
*

13 6 6 6 5 5 5 4 3 2 2 2 2 2 2 2 2 2 2 27

Airconditioning, Ceramics, Cigarettes, Computers, Dye-stuff, Diamond, Fertiliser, Mining, Lubricants, NBFC, Shipping, Printing, Telecom, Tractor, Tyres, Glass, Welding, Fasteners

Product Attribute Technology Brands Commodity Business Activity Focussed Diversified

% 51 21 28 % 87 13

Commodity businesses form a minor percentage of the group. Companies that are focussed on their core businesses form 87% of the group: few diversifed companies have made the grade as wealth creators. Competitive sectors of the economy have also produced successful wealth creators - Of the Inquire 100, 33 companies enjoyed a predominant market share in their respective industries. Businesses with high entry barriers arising out of proprietary knowledge in technology and marketing such as in pharmaceuticals, enjoy a strong representation.

Wealth Creators - Categorised

Blue Chips have been defined as those companies which have had a consistent earnings record. As can be seen above Blue Chips have done exceedingly well. The environment of deregulation, competition, mergers & acquisitions is likely to see established blue chips consolidate their position further. Fast growers have grown their turnover at greater than 30% p.a. over the period of the study. We believe this group of companies will maintain a strong presence in the category of wealth creators of the future. We expect the demands of a competitive environment to push a larger number of companies towards restructuring and this could be a fertile ground to locate wealth creators. Identifying turnarounds at an early stage can be highly rewarding though somewhat risky. Very few new entrants have been able to create meaningful wealth at an early stage of their existence. The rate of wealth creation has been much faster in case of turnaround and new entrants compared to blue chips and fast growers.

Wealth Creators - Capitalisation Size

Rs. Cr.

Of the Inquire 100, 80 companies had a market capitalisation of Rs.150 crores or less in 1991. The median market cap was Rs.92 crores for the Inquire 100. Of the top 25 market cap companies of 1991, 6 have found representation in the Inquire 100. However, they do not find a place in the first 25 wealth creators in the Inquire 100. Thus the speed of wealth creation comes from the mid & small cap companies. However, the surety of wealth creation is greater for large cap stocks given their strike rate of 25% amongst the top 25 large cap companies in 1991.
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Wealth Creators - Sales Growth (CAGR)

No. of companies

Sales Growth (CAGR %)

A very high rate of sales growth does not necessarily translate into wealth creation. Of the Inquire 100, 68 constituents grew sales during the period of study between 10% to 30% CAGR. The median rate of growth was 23%. This moderate rate of sales growth was sufficient to generate shareholder return of 32% p.a., implying that these companies - were able to adequately leverage fixed costs - were able to control operating costs - did not over stretch themselves financially - were able to increase margins, and - were able to increase the overall asset utilisation

Wealth Creators - Capital Intensity

No. of companies

Fixed Assets Turnover Ratio

The majority of companies in the Inquire 100 enjoy a relatively high Fixed Asset Turnover ratio implying low capital intensity. Given the predominance of technology and marketing based companies in the Inquire 100 this is not surprising. With intellectual capital becoming increasingly recognised and playing a more important role in the current business environment, this trend is likely to be maintained.
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Wealth Creators - Debt Growth (CAGR)

No. of companies

Debt Growth (CAGR %)

As many as 68 of the Inquire 100 have either reduced debt or grown it conservatively. This implies that wealth creators progressively improve their financial position using internal generation to bring down their overall cost of capital (see pg 9 on Payout Policy). Wealth Creation does not appear compatible with strategy of aggressive financial leveraging.

Wealth Creators - P/E - Tax Ratio correlation

P/E Ratio

Percentage of tax to PBT

Wealth Creators don't disappoint the exchequer. Paying tax not only benefits the governement - it's good for shareholders too because of the perception of a superior quality of earnings which is rewarded by a higher P/E ratio. Of the Inquire 100, only 10 companies were zero tax payers for the period under study. More than half of the constituents paid an average tax rate of 20% or more. This shows that a high rate of tax is not an impediment to wealth creation - as the market accords a higher P/E ratio to a high tax paying company. The higher P/E multiple is a reflection of the sentiment of investors for the quality and sustainability of earnings of tax paying companies.
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Wealth Creators - Rights/Bonus

BONUS No 31 20 51

CAGR Returns (%)

BONUS No 38.9 44.3

R I G H T S

Yes Yes No Total 25 24 49

Total 56 44 100

R I G Yes H No T S

Yes 46.4 42.4

Of the Inquire 100 as many as 56 companies issued rights in the period of study and 49 issued a bonus. This implies that issuance or non-issuance of rights or bonus does not have an impact on satisfying the criterion for entry into the wealth creators list - Inquire 100, as long as the capital deployed by the company yields an adequate return.

Wealth Creators - Dividend Payout

Dividend Payout Ratio (%) Average dividend distributed as a percentage of net profits is 25.86%.

The majority of the Inquire 100 appear to follow a conservative dividend payout policy. This allows for a high ploughback into the business facilitating - Repayment of costly debt - Redeploying funds at a high rate of return on capital employed in the business thus bringing into play the effect of compounding whereas in case of distribution of dividend, shareholders are taxed a second time on the dividend received, thus reducing their post-tax return further.

Wealth Creators - Return on Equity (ROE)

Avg. ROE 23.17

No. of companies

Return on Equity (%)

Shareholder's wealth in the company is not just the equity capital but reserves as well. EPS indicates return on equity capital whereas ROE shows the earnings on total shareholder funds retained in the business. ROE sets the pace at which a company is creating wealth. It is observed that high ROE companies are given high P/E which in turn leads to higher wealth for shareholders in terms of higher market capitalisation.

Wealth Creators vs Sensex Companies - ROE Relative

ROE Relative

The wealth creating companies typically beat the market because they have higher ROE than the sensex scrips. The pace at which networth increases is higher in these companies and with the benefit of compounding, not only do the rich become richer but at a faster pace as well.

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Wealth Creators - ROCE & ROE

The ROCE and ROE of the Inquire 100 show a secular rise over the period of study. This shows a sustained improvement by these companies in the productivity of assets which is an integral part of the process of wealth creation. The relatively high ROCE & ROE implies the ability of these companies to earn a return higher than their cost of capital.

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An Observation on Valuation
Wealth Creation occurs when a great management runs a great business. But, for an outsider to buy into such great businesses through the stock market, he must enter at the right price to earn substantial appreciation . This led us to ask what constitutes the right price? The price of a stock comprises both qualitative and quantitative factors. The EPS is a statistical derivation and forms the quantitative factor. The qualitative factors get built into the PE ratio. This makes us ask what should be the PE ratio accorded to a stock? Study reveals that in 1991, as many as 63 of the Inquire 100 were trading at a substantially lower PE ratio to their respective ROEs. We also found that by 1996, in most of these cases the PE ratios had caught up with the level of the sustainable ROE. This drew us to the conclusion that the PE ratio accorded should be closer to the sustainable ROE of the company. Consequently, there is an inherent margin of safety in buying a stock at a P/E ratio substantially lower than its sustainable ROE. This is where the opportunity lies.

The conclusion
The search for wealth creators is an eternal endeavour. The study does reveal that wealth creating companies have substantial corelation with a high ROE. Buying them at a P/E lower to ROE could result in substantial capital appreciation. However, right judgement of long term sustainability, prosperity of business and responsible management play a crucial role in identifying wealth creators.

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Inquire 100 Wealth Creators

Inquire Rank Rank based on size Company Name CAGR of adjusted Mcap. (%) 98.0 95.3 89.7 89.0 85.7 79.9 79.8 76.9 75.6 75.6 74.1 70.7 70.2 69.9 67.6 67.1 67.1 66.8 66.1 65.7 63.3 62.9 62.5 62.2 61.2 56.0 55.9 55.4 55.2 54.1 53.7 53.6 52.8 51.6 51.2 50.9 50.7 50.1 49.7 49.1 48.4 47.7 47.6 47.0 47.0 46.7 46.4 45.5 45.5 44.7 Amount of Wealth Created (Rs. Cr.) 539.7 456.2 598.3 501.4 466.6 219.1 3144.4 2201.8 168.5 256.2 2755.2 276.1 1284.6 1853.4 1749.2 2394.5 599.1 692.0 371.0 153.8 106.0 148.4 376.3 122.7 607.0 126.6 7829.4 2149.8 179.9 101.5 5736.2 133.2 932.8 248.9 308.1 599.7 317.4 143.3 9102.2 2023.9 106.1 1592.7 464.7 463.7 151.8 222.8 102.5 200.8 421.2 163.1 CAGR of Sales (%) 50.1 37.9 23.5 49.8 23.2 47.2 22.1 32.0 48.2 24.8 28.1 31.7 24.0 23.8 25.5 29.0 21.0 26.5 30.2 13.0 54.0 27.6 39.5 14.4 68.9 19.6 7.4 22.5 31.6 29.2 20.3 34.7 17.7 14.6 13.9 34.8 40.1 36.9 22.1 18.0 39.6 29.6 20.0 23.3 20.3 13.0 23.7 27.3 24.6 132.0 CAGR Net Profit (%) 64.2 44.5 52.2 70.3 30.6 54.7 32.3 32.6 45.5 41.1 54.4 41.9 29.5 25.8 38.2 52.1 24.2 29.4 73.4 28.5 74.0 27.5 50.3 32.8 69.9 24.4 11.6 27.4 46.7 18.0 33.7 37.3 13.5 20.3 26.8 42.4 57.7 42.4 23.8 25.9 36.1 37.6 27.0 1.3 43.2 15.7 28.0 41.3 32.7 150.9

Appendix I
(Period : 1991-96)
Wt. Avg. ROE (%) 39.6 40.1 43.8 29.5 15.9 38.4 27.1 19.1 23.0 30.9 24.9 29.7 33.3 20.0 22.7 35.4 26.6 26.6 14.4 22.1 36.8 31.6 25.3 12.2 41.8 11.4 11.1 18.7 21.2 35.8 37.9 70.4 16.1 9.1 28.3 17.4 16.8 26.9 31.6 13.2 54.8 23.8 23.5 22.5 29.0 21.7 23.0 22.3 21.2 20.3 Abs. Chg. in ROCE 1991-96 (%) -14.0 0.3 34.5 -23.3 -12.7 13.6 9.9 1.8 37.4 -2.1 1.2 9.2 0.3 12.0 10.8 14.4 14.2 -1.4 39.1 25.3 94.5 23.3 10.7 7.8 2.8 9.5 -0.2 21.7 17.7 3.9 -3.0 30.9 -6.8 12.9 14.0 -2.7 -5.0 4.6 6.1 7.5 29.3 -17.1 8.6 32.6 24.5 -8.1 7.6 -5.1 15.5 -1.3

1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27 28 29 30 31 32 33 34 35 36 37 38 39 40 41 42 43 44 45 46 47 48 49 50

37 42 35 38 39 64 7 11 75 58 9 56 17 14 15 10 34 28 48 78 97 81 46 91 31 89 2 12 72 100 4 88 25 61 52 33 51 84 1 13 96 16 40 41 79 63 99 68 44 76

Dr Reddys Labs Vysya Bank TVS Suzuki United Phosphorus Oriental Hotels Himatsingka Seide Indian Hotels H D F C Trafalgar House Essel Packaging Ranbaxy Labs Thomas Cook Madras Cements E I Hotel Asea Brown Boveri Castrol Sund Fastners CIPLA Carrier Aircon Advani Oerlikon Monsanto Chemicals Shriram Honda Hotel Leela Venture Tata Press Saw Pipes Chicago Penumat SBI MICO Raasi Cement Asahi India Safe ITC Nippondenso MRF Sundaram Clayton Sandvik Asia Wipro Nicholas Piramal Kajaria Ceramics Hind Lever M & M Siltap Chemicals Guj Ambuja Cement Punjab Tractors Knoll Pharma Piramal Healthcare Widia India Gabriel Finolex Cables Zuari Agro Himachal Futuristic

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Inquire 100 Wealth Creators (contd.)

(Period : 1991-96)
Inquire Rank Rank based on size Company Name CAGR of adjusted Mcap. (%) 44.7 44.4 43.6 43.6 42.8 42.5 42.3 42.2 42.2 42.1 42.0 41.9 41.7 41.7 41.5 41.4 41.4 41.3 40.3 40.0 39.1 38.2 38.1 37.7 37.6 37.4 37.3 37.0 36.9 36.4 35.8 35.7 35.5 35.1 35.0 34.6 34.5 34.3 34.3 33.9 33.8 33.5 33.0 33.0 32.7 32.1 32.0 32.0 32.0 32.0 Amount of Wealth Created (Rs. Cr.) 118.9 208.5 231.5 135.1 126.2 1127.0 3112.4 178.9 285.3 568.1 103.2 633.2 432.1 1208.6 4923.0 954.6 287.6 150.9 724.4 192.3 170.6 206.0 1141.7 4005.3 611.2 190.0 381.3 117.8 1111.2 187.0 1161.4 145.6 251.4 117.6 140.5 145.0 163.0 290.1 771.7 110.8 374.7 204.7 945.2 7074.0 367.8 362.2 274.3 604.0 250.5 136.5 CAGR of Sales (%) 20.1 29.8 18.5 33.6 19.5 19.3 23.7 9.6 15.8 2.7 18.5 28.8 25.9 25.3 16.2 19.3 18.5 54.4 29.7 15.1 9.7 32.3 19.2 13.2 33.5 26.1 33.2 11.2 17.8 15.7 21.6 -66.7 12.9 15.0 30.2 36.9 22.8 21.8 20.4 98.9 21.1 16.0 27.3 24.1 19.1 20.0 13.5 53.6 19.6 10.1 CAGR Net Profit (%) 13.8 41.7 26.9 31.4 10.5 40.1 27.8 1.8 65.2 11.0 12.0 22.2 29.9 25.0 23.4 17.7 26.8 56.5 27.7 22.0 35.7 33.2 25.6 33.8 55.7 31.7 22.8 36.5 21.4 20.6 28.9 -66.7 13.8 12.4 43.8 68.3 32.8 15.1 27.7 134.2 20.5 27.5 61.6 21.8 21.8 25.9 19.3 65.5 17.7 34.1 Wt. Avg. ROE (%) 19.3 12.9 22.9 18.8 22.9 35.1 22.1 8.1 22.2 14.6 17.6 24.1 30.6 14.6 23.2 34.3 19.3 23.1 21.7 24.9 30.4 10.4 23.7 20.0 15.8 22.8 14.8 19.6 21.3 18.9 15.0 0.0 19.5 16.4 25.8 27.5 19.1 19.0 13.4 27.8 30.7 18.3 18.7 15.6 13.8 12.7 18.9 26.8 21.2 35.0 Abs. Chg. in ROCE 1991-96 (%) -0.7 4.2 12.5 -32.7 -19.2 24.1 2.5 -6.9 -0.3 19.4 11.8 -21.7 1.7 -7.2 13.8 17.8 -3.0 -8.0 0.1 14.5 9.2 16.9 9.9 -4.4 4.7 11.6 -3.0 19.1 7.8 -1.2 5.8 -8.4 14.2 1.8 -12.5 25.8 -5.7 -1.6 -1.8 -22.6 27.3 23.0 -8.9 -5.1 -3.7 -3.8 8.4 -0.1 6.6 -25.8

51 52 53 54 55 56 57 58 59 60 61 62 63 64 65 66 67 68 69 70 71 72 73 74 75 76 77 78 79 80 81 82 83 84 85 86 87 88 89 90 91 92 93 94 95 96 97 98 99 100

92 65 62 87 90 21 8 73 55 36 98 29 43 18 5 23 54 80 27 69 74 66 20 6 30 70 45 93 22 71 19 82 59 94 85 83 77 53 26 95 47 67 24 3 49 50 57 32 60 86

Zandu Pharma K E C Intl Goodlass Nerolac ITW Signode APR Ponds Tata Chemicals Rhone-Poulenc(I) Garware Polyester ICI Engine Valves Sesa Goa Hero Honda Siemens Bajaj Auto Glaxo India Colour Chem Flex Inds Great Eastern Cyanamid India Eternit Everest Tata Invest Corp Kirloskar Cummins Hindalco India Cement Wartsila Diesel Apollo Tyres Atlas Copco Asian Paints Dalmia Cement Indian Rayon Madras Aluminium Sandoz Rane (Madras) Cheminor Drugs Nalco Chemicals Max India Smithkline Bee Pharma Tata Power Jindal Iron Asian Hotels E Merck (India) BSES Telco Crompton Greaves Andhra Valley Rallis Sterlite Inds BASF Godfrey Phillips

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Inquire 100 Wealth Creators

Inquire Rank 20 96 77 55 30 15 91 79 78 65 99 93 19 16 85 26 18 67 95 70 80 1 14 92 61 10 71 48 68 47 59 66 100 53 69 42 8 63 50 6 39 74 23 60 75 7 81 31 54 90 Company Name Advani Oerlikon Andhra Valley Apollo Tyres APR Asahi India Safe Asea Brown Boveri Asian Hotels Asian Paints Atlas Copco Bajaj Auto BASF BSES Carrier Aircon Castrol Cheminor Drugs Chicago Penumatic CIPLA Colour Chemicals Crompton Greaves Cyanamid India Dalmia Cement Dr Reddys Labs E I Hotel E Merck (India) Engine Valves Essel Packaging Eternit Everest Finolex Cables Flex Inds Gabriel Garware Polyster Glaxo India Godfrey Phillips Goodlass Nerolac Great Eastern Gujarat Ambuja Cement H D F C Hero Honda Himachal Futuristic Himatsingka Seide Hind Lever Hindalco Hotel Leela Venture ICI India Cement Indian Hotels Indian Rayon ITC ITW Signode Jindal Iron Rank based on size 78 50 45 90 100 15 47 22 93 5 60 24 48 10 85 89 28 54 49 69 71 37 14 67 98 58 74 68 80 99 55 23 86 62 27 16 11 43 76 64 1 6 46 36 30 7 19 4 87 95 Inquire Rank 52 38 73 44 82 13 40 87 28 21 33 86 37 32 5 45 56 43 29 97 11 84 58 83 35 25 27 62 22 64 41 88 98 17 34 57 89 24 72 94 12 9 3 4 2 76 46 36 51 49 Company Name K E C Intl Kajaria Ceramics Kirloskar Cummins Knoll Pharma Madras Aluminium Madras Cements M & M Max India MICO Monsanto Chemicals MRF Nalco Chemicals Nicholas Piramal Nippondenso Oriental Hotels Piramal Healthcare Ponds Punjab Tractors Raasi Cement Rallis Ranbaxy Labs Rane (Madras) Rhone-Poulenc(I) Sandoz Sandvik Asia Saw Pipes SBI Sesa Goa Shriram Honda Siemens Siltap Chemical Smithkline B Pharma Sterlite Inds Sundaram Fastners Sundaram Clayton Tata Chemicals Tata Power Tata Press Tata Invest. Corp Telco Thomas Cook Trafalgar House TVS Suzuki United Phosphorus Vysya Bank Wartsila Diesel Widia India Wipro Zandu Pharma Zuari Agro

Appendix II
Rank based on size 65 84 20 41 82 17 13 77 12 97 25 83 51 88 39 79 21 40 72 57 9 94 73 59 52 31 2 29 81 18 96 53 32 34 61 8 26 91 66 3 56 75 35 38 42 70 63 33 92 44

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NOTES

For more copies or other Inquire Research Call : (9122) 207 3809/ 207 1379 Fax (9122) 207 66 86
This document is for information purposes only. In no circumstances should it be used or considered as an offer to sell or a solicitation of any offer to buy or sell the securities or commodities mentioned in it. The information in this document has been obtained from sources believed reliable, but we do not represent that it is accurate or complete, and it should not be relied upon as such.

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